Tax policy debate needs wider focus

By Brian Fallow

WELLINGTON - The top-to-bottom review of the tax system promised by the Labour Party if it wins power is overdue, in John Shewan's view.

The managing partner of PricewaterhouseCoopers and one of New Zealand's pre-eminent tax accountants, Mr Shewan said it was a pity the tax policy debate this year would be focused on the narrow issue of tax rates.

"We are going to fluff around talking about the difference between 39c and 33c when there are much more significant issues longer-term."

These issues included:

* The treatment of retirement savings, currently "a shambles".

* The appropriate mix of direct and indirect taxation, when the former is under pressure from globalisation.

* Whether New Zealand should continue to be the only OECD country without a comprehensive capital gains tax.

* Whether the Government should continue to give tax incentives for investment in forestry, or start giving them for research and development.

* Whether the tax system should be used to deliver social welfare benefits.

Demographics should be driving the tax debate, Mr Shewan said. What would the tax requirements be in 2010 or 2020 and how would they be met?

"There are major problems if the tax system stays as it is," he said. "There is a strong incentive to emigrate rather than fund the retirement benefits of an aging population."

While many of the countries New Zealanders might want to emigrate to also faced the challenge of an aging population, they also had stronger economies.

Mr Shewan said global competitive pressures would strengthen the tendency for governments to rely more and more on indirect taxes (on spending) rather than direct taxes of individual incomes and corporate profits.

"People are far more mobile than we ever used to be. Therefore taxing people on the basis of residence is problematic if the tax regime is unattractive. People will simply move."

Electronic commerce poses a threat to some indirect tax revenue too, especially relating to software. It becomes anomalous, for example, to continue levying GST on a compact disc when the same music can be downloaded through the Internet and escape tax.

"I don't downplay the significance of that. Generally, however, indirect taxes are hard to avoid, because people will always spend. But you cannot counter the avoidance of direct taxes without having rules which say you must not emigrate and you must have your business in this country. And of course you can't do that."

Australia, in the throes of a major overhaul of its tax system, has stated the objective of reducing the corporate tax rate to 30 per cent though it has yet to commit to that.

That would put pressure on New Zealand to reduce its company tax rate, currently 33c, as well, whoever was in power. Labour's review of the tax system would look afresh at the taxed-taxed-exempt (TTE) regime for savings put in place by Sir Roger Douglas.

Under TTE retirement savings come out of after-tax income, the income they generate is taxed in the hands of fund managers and other financial intermediaries, but the eventual payout is exempt.

"I'm not advocating tax incentives for savings because I don't know enough about the impact on the economy," Mr Shewan said.

"New Zealand economists are generally of the view that providing tax deductions for savings will distort investment behaviour and upset the economy. Maybe they are right. But it needs to be looked at because other economies - including the United States and Australia - do it and they seem to have stronger performing economies."

As it is, investment decisions are distorted by the fact that some forms of savings escape tax on capital gains - residential properties for example - while others, such as managed funds, do not.

"A capital gains tax would go some way towards levelling the playing field, but I am not advocating one. For every economist who thinks it's an excellent idea you find another who thinks it would cause a massive capital outflow and be very damaging to the economy."

Mr Shewan said he suspected some form of capital gains tax would be the principal outcome of Labour's review. It would be likely to exclude the family home, be indexed for inflation, and be incurred only when the assets were realised.

But he warned that introducing such a tax when the top personal tax rate was 39c would mean most gains would be taxed at that rate.

That would be a disincentive to save, invest and be entrepreneurial, and an incentive to seek greener pastures.